Indexed Universal Life Insurance and Investment Only Variable Annuity

One of the things I enjoy about being a Financial Planner is learning about new strategies and tools to help clients reach their financial goals.

Two  I’ve seen lately are  ‘Indexed Universal Life Insurance’ and ‘Investment Only Variable Annuity’.

Life Insurance and Annuities come in many different compositions and can play an important part in a client’s life.

Unfortunately, they can also be incredibly confusing and opaque.

I mean, I do this for a living, and sometimes when I have a client that has one of these 2 new products, I scratch my head at all the moving parts and, at times, conflicting information on these products.

So I’m going to take a stab at distilling these products down to the most simplest language I can.

Indexed Universal Life Insurance: This product tries to be many things to accomplish various goals. It’s life insurance.  It’s premium is adjustable.  It’s cash value is adjustable. It’s death benefit is adjustable.

It can be a fixed account or a variable account.

Fixed means the growth is guaranteed, although it tends to be very low, and is analogous to a savings account in concept.

Variable means the growth is not guaranteed, and it’s growth is a result of being invested in investments.

It’s ‘balance’, known as the ‘cash value’ of the account grows tax deferred, meaning you don’t pay taxes on it until you take a distribution on it. The fact that it uses the word ‘indexed’ is confusing to many people, because most people’s reference point for ‘index’ in the financial planning world is a market index, such as an S&P 500 index.

But in this product, the word ‘indexed’ means that the growth is ‘linked’ to the performance of a set of investments, such as stocks.  However, this product is not directly invested in these investments. The client chooses which market they want their account to be ‘indexed’ to, and their balance is increased with the growth of that market after a given amount of time, say 6 months, or increases only by the minimum percentage that is guaranteed (say, 2%). This indirect link makes this product hard to explain to clients, and makes it hard for clients to understand if they already own it. The fact that the balance is part fixed and part variable adds another layer of complexity.

Who should invest in this product? It’s a pretty sophisticated product, and hard to understand for most people. It can play a role with a client who has a certain level of financial sophistication, can understand the links between the life insurance component and the cash value component, and then can understand how the cash value grows either by a minimum guaranteed percentage or by the growth of the markets the client decided to ‘index’ to. It usually benefits clients who are looking for tax deferred growth above their employer retirement plans and for those who are doing some estate planning.

Investment Only Variable Annuities:  This is an annuity product. An annuity provides you with a monthly benefit. If it’s a fixed annuity, the monthly benefit is fixed. It it’s a variable annuity, the monthly benefit is variable.  It is a product you purchase so that you can be ensured of having a certain monthly benefit in the future, say when you retire or when you exceed the age at which you thought you would live (say, the age of 95).

Variable Annuities have been notorious for having many moving parts and for not clearly stating in one place all of the fees related to owning them.

The owner of a variable annuity has choices in where to invest their money.  The choices are provided by the company that offers the annuity.  The choices can range from a stock mutual fund to alternatives such as real estate investment trusts.

An Investment Only Variable Annuity offers the opportunity to own a variable annuity in a simpler fee structure.  There is no guarantee that it will grow at a minimum amount, which is what a standard Variable Annuity offers.

Instead, an Investment Only Variable Annuity is exactly that: It grows purely by what it is invested in. What it is invested in is decided by the client.  The investment choices can be the full range of investments, from stock mutual funds to alternatives such as real estate investment trusts. It has a flat fee, which makes it easy to understand exactly how much it is costing you.

Who should invest in this product? It is a pretty sophisticated product, and needs to be clearly understood as not risk free. The client needs to be comfortable with risk and with the possibility that growth will be uncertain. It is for a client who values this product for it’s growth potential and, since growth is not taxed until distributions are taken, it’s tax deferred growth.  The client decides which options to invest in, and there is no guarantee that those investments will grow at a certain rate.

So let’s take a stab at boiling the benefits of these 2 products down.

Who would benefit from considering these products? Someone who:

1. Has exceeded the contribution limits to their employer retirement plan and other tax deferred plans.

2. Wants more tax deferred growth

3. Is comfortable with uncertain growth

4. Understands the key concepts and risks of investments

5 . Wants a future cash value (key part of insurance) or monthly benefit (key part of an annuity)

Understanding these products is a big step towards understanding their role in a client’s portfolio.

Without understanding them, either on the part of the adviser or the client, the decision will not be made in a fully informed manner and may result in a disappointed client who didn’t understand what they purchased.

That doesn’t make these products bad. It just underscores their comprehensive and sophisticated nature.